As we mentioned in Tuesday's "Link of the Day," the Bank of England and Financial Conduct Authority published a discussion paper entitled, "Resilience of Money Market Funds," which reviews money funds in the U.K. and pending European money fund regulatory reforms. The paper says, "In November 2020, the Financial Stability Board (FSB) published a Holistic Review of the March Market Turmoil, and began work on policy options to enhance MMF resilience. In October 2021, the FSB published its Final Report on possible policy proposals to enhance MMF resilience. FSB members agreed to assess and address the vulnerabilities that MMFs pose in their jurisdiction by utilising the framework and policy toolkit set out in the report. The UK contributed to and worked with the FSB on the report."
It explains, "This Discussion Paper (DP) is a contribution to an assessment of the vulnerabilities in MMFs and how much they contribute to risks to UK financial stability and investor protection. It aims to contribute to the debate about how to reduce such risks while also ensuring that the structure of the financial system and UK market support the needs of the real economy in a sustainable and robust way. It aims to gather views to inform the UK authorities' development of MMF reform proposals, and where possible, to set out the UK authorities' initial views on the possible effectiveness and proportionality of some reform options."
The paper continues, "In relation to MMFs, UK authorities aim to adopt policy measures following feedback received from this DP that will: i. Strengthen the resilience of MMFs and the financial system in supporting the UK economy. ii. Reduce the need for future extraordinary central bank interventions of the kind that occurred in March 2020 [and] iii. Support the provision of sustainable and robust cash management financial services that meet the needs of users including at times of financial stress."
The Introduction comments, "Chapter 2 discusses the current role of MMFs in the UK economy, who uses them and for what purpose, including on a cross-border basis. We also explore the MMF legal and regulatory framework. Chapter 3 discusses the nature and extent of the systemic risk that MMFs pose and the vulnerabilities within their structure that may amplify risks to the UK, using past events as case studies. Chapter 4 discusses the set of policy options the FSB proposed to enhance MMF resilience. Where possible, this chapter also puts forward the UK authorities' initial thinking on the possible effectiveness and proportionality of those options.... Please respond to this DP by 23 July using the details on the Contents page. The UK authorities will consider feedback in deciding whether to formally consult on one or more MMF reform proposals."
On "The role of MMFs in the UK economy," the Bank of England and FCA write, "MMFs are a type of authorised open-ended investment fund (OEF) that invest in short term money market instruments. Globally, MMFs had over 7 trillion of assets under management (AUM) as at 31 December 2021. AUM of sterling-denominated MMFs have more than doubled since the 2008 global financial crisis, standing at around 280 billion at December 2021. This section sets out how UK investors use sterling MMFs, the role of sterling MMFs in markets, and explains the current legal and regulatory framework for MMFs that UK investors use."
They continue, "Among UK investors, MMFs are predominantly used by investment funds, pension funds, other non-bank financial institutions, non-financial corporates, local authorities and charities. Many investors use MMFs as part of their cash management strategies because MMFs offer 'same day liquidity'. Unlike other OEFs, MMFs tend to prioritise stability of value over maximising return, and aim to deliver rates consistent with the short-term money market."
The paper says, "The way different types of investor use MMFs varies. Most UK MMF investors use sterling MMFs, although a number of large corporates and financial institutions based in the UK also use MMFs denominated in other currencies, including US dollars and euros.... Non-financial corporates (mostly large or medium sized) use MMFs as a way of managing cash balances. These balances may come from monthly payroll, from the proceeds of a bond issuance or in the run of up to large capital expenditure. Non-financial corporates often treat MMFs as similar to bank deposits, and many account for them as 'cash equivalent' on their balance sheets, despite MMFs being clearly labelled as investments. For example, Bank of England analysis estimates that around half of FTSE 100 companies use MMFs to some extent."
It adds, "Financial institutions, such as insurers, pension funds and other investment funds, also use MMFs as a way of managing cash, including as a place to hold cash they may use for margin payments. Margin calls may increase when market volatility increases, and financial institutions need to be able to access cash on demand to pay margin calls. Failure to access their cash could result in increased likelihood of default. In the non-profit sector, local authorities and charities use MMFs to manage tax receipts and donations. Those institutions may be more sensitive to losses than financial institutions, no matter how small, given their not-for-profit mandate. Individual UK retail investors account for a small proportion of overall MMF shareholders by assets."
The Discussion Paper also tells us, "While MMFs offer same day liquidity to their investors, MMFs provide a return by investing in assets with residual maturity (the length of time before an investment matures) longer than a day. MMFs typically invest in bank deposits, UK government bills, certificates of deposit (CD), commercial paper (CP), asset-backed commercial paper (ABCP) and reverse repurchase agreements.... This means MMFs run a liquidity mismatch, potentially increasing the likelihood of investor redemptions under some circumstances."
It comments, "In terms of assets, UK investors predominantly use sterling MMFs domiciled in the EU.... EU MMFs come under the EU Money Market Fund Regulation (EU MMFR). UK MMFs must be authorised under the UK MMFR. The EU law version of the MMFR was retained in UK law as the UK MMFR through the European Union (Withdrawal) Act 2018 (EUWA)."
Finally, Chapter 4, "Tackling risks to the UK financial system - discussion of policy options," states, "In October 2021, the FSB published its Final Report on policy options to reduce vulnerabilities and enhance the resilience of MMFs. FSB members agreed to assess the vulnerabilities in their own jurisdictions and implement any necessary reforms using the policies outlined in the report." Options include: "`Asset-side reduction in liquidity transformation. One way to enhance the resilience of MMFs is to reduce liquidity transformation by requiring them to hold more liquid assets. Larger holdings of more liquid assets that are more readily convertible into cash either through their ability to be sold, or by maturing within a shorter period, would increase the ability of MMFs to meet redemptions."
They also include: "Placing minimum requirements for holdings of assets that mature within a certain amount of time (such as daily or weekly liquid assets).... Placing minimum requirements for holdings of assets that tend to exhibit higher market liquidity such as holdings of high quality public sector debt. This option would require MMFs to hold a certain amount of assets such as short[1]term government debt, and could be required alongside DLA/WLA requirements.... Placing maximum limits on holdings of assets that tend to exhibit lower market liquidity, particularly under stress (such as holdings of private sector issued CD and CP). This option would place an upper limit on the amount of less liquid assets an MMF can hold, such as CP and CD.... Removal of threshold effects related to liquidity levels, and usability of liquidity resources.... Impose on redeeming investors the cost of their redemptions. One way to minimise the first mover advantage for redeeming investors is to impose on them the true costs of their redemptions.... Swing pricing/anti-dilution adjustments or anti-dilution levies/liquidity fees are examples of liquidity management tools (LMTs).... Removal of stable NAV.... Liability side reduction in liquidity transformation. Policies to absorb losses [and] Issues related to the underlying short-term funding markets (STFMs)."
